In the mid-1960s as a young accountant, I began helping my pastor prepare his state and federal tax returns. I was surprised at his meager salary, lack of fringe benefits, and inability to provide financially for his future. His family lived in a church-owned parsonage totally controlled by the church; they couldn’t even paint a wall without committee approval. It was a large farmhouse that was difficult to maintain and expensive to heat. I remember visiting that parsonage and finding his wife in tears over the frustration of living under those conditions. And I remember thinking, This is not right. Little did I know how that experience would begin to sow the seeds for the Stewardship Services Foundation, a ministry that would allow me to devote my energies to counseling pastors regarding finances, helping them prepare their personal income tax returns, and teaching church boards how to structure pastors’ salary packages within the limits of IRS tax law. As a result, in 1977 the Stewardship Services Foundation ministry was born.
A church board needs to know about salary packages and their proper application in the budget process. The most important issue when it comes to this subject is the board’s attitude-a proper understanding of the salary package issue and the desire to meet the needs of the pastor’s family with a spirit of generosity.
When a church calls a pastor (whether he be senior, youth, music, or visitation), it is important to consider the following eight issues.
According to IRS tax law, pastors employed by churches have a dual-status treatment in the Internal Revenue Code. This “dual-status” distinction can be confusing to congregations, who do not always understand why a pastor can be considered an employee (income tax reporting) and self-employed (Social Security reporting) at the same time.
For income tax reporting, pastors are to be treated as employees [see "common law rules" in Reg. 31.3401(c)-1]. The church is not required to withhold income tax for the dual-status pastor [see Sec. 3401(a) (9)]; this is optional.
For Social Security and Medicare reporting, pastors are considered self-employed [see Sec. 1402(a) (8)]. Churches cannot withhold FICA and Medicare taxes for their pastor. As a result, pastors receive a W-2 at the end of the tax year with boxes 3, 4, 5, and 6 left blank or with “none” entered in each space.
Pastors must carefully plan throughout the year, or they will be left with a significant payment at the end of the tax year. Pastors have two options for paying.
A pastor can pay his self-employment tax by the church’s withholding it as additional federal income tax; or
A pastor can pay his self-employment tax by quarterly payments using form 1040-ES.
A bit of history: Prior to 1994, pastors were considered self-employed for income tax reporting. Then a court ruling declared that a pastor is an employee and therefore the employer (church) must report earnings on Form W-2. Churches have generally incorporated this change, but the distinction is sometimes lost on accountants who do not have experience with the unique tax status of pastors. Even after the court ruling, pastors continued their self-employed status for Social Security and Medicare taxes, adding to the confusion.
A pastor pays the self-employment tax on the total of his wages including his housing allowance (if buying or renting). In the event that he lives in a church-owned parsonage, he pays his self-employment tax on the total of his wages including the parsonage value and church-paid utilities.
Paying the additional self-employment tax can be a hardship for the pastor. Congregation members often forget about the impact of this 15.3 percent deduction, and as a result have an inflated impression of the pastor’s compensation package. Comparing a pastor’s salary to your own leads to confusion.
I realize that these numbers may be currently out of reach for some churches. However, stewardship principles require each of us to be responsible with the resources and family God has entrusted to our care.
A good procedure is to assign two respected church leaders to review the needs of the staff annually and to make recommendations to the church for consideration. Perhaps the pastor could be treated to an informal lunch where his financial needs can be sensitively discussed. It is appropriate for church leaders to ask the pastor if he is keeping current with his financial obligations, and to ask if his needs are being met.
When it comes to our pastors, we should take 1 Corinthians 9:14 and 1 Timothy 5:17 seriously. Addressing all of these issues at one time may be difficult. But by prayer, planning, and proper stewardship, a church can address every single one.
Jim Rickard is a certified public accountant and the director of the Stewardship Services Foundation, which advises churches and pastors about financial issues. His foundation prepares tax returns for more than 2,000 pastors nationwide, including hundreds of our pastors in GARBC churches.